Forgive debt to pump up your business tax-free

Forgive debt to pump up your business tax-free Does your company need a quick cash transfusion to keep operating on all cylinders? That could be a problem if the company owes you money for a prior debt.

Strategy: Forgive the debt, and treat it as a contribution to your business. If you do this properly, neither you nor the company has to pay any tax on the transaction.

Normally, debt forgiveness results in taxable income to the organization, called cancellation- of-debt (COD) income. But a loophole in the tax law allows your company to effectively sidestep COD income when you forgive what the company owes you.

Example: Dodge the COD tax bullet

Let’s say your company incurs $100,000 of debt. After it pays $25,000 of the debt, it experiences financial difficulties. So, you negotiate with the creditor to forgive the remaining $75,000 of debt in exchange for $50,000 of common voting stock.

Under those facts, your company would face $25,000 ($75,000 minus $50,000) of COD income.

It’s a different story, though, if the company owes you or another shareholder the money. If you simply contribute the debt to the organization’s capital structure without receiving any stock in exchange, the company incurs no COD income.No COD income = no tax.

Sidestep potential tax pitfalls. Don’t take any additional company stock in exchange for forgiving the corporate debt. That could trigger taxable COD income for your company. And you have no real reason to do it if you own all the outstanding shares.

Here’s why: Since you already own 100 percent of the company, you’re in the same position as you were before forgiving the debt. So, you can avoid unnecessary tax by simply doing nothing.

Tip: Consult your tax pro, since this is a highly technical area of the tax law.